Light at the end of the tunnel for emerging market debt

Peter Marber, CIO Emerging Markets at Aperture Investors (part of Generali AM ecosystem)

We are cautiously optimistic for 2024. The US looks close to ending its hiking cycle as its economy cools. Typically, market turnarounds precede rate cuts, and recent months have shown a turn in market sentiments. A late 2023 risk rally helped propel most EM hard currency indices to potentially finish the year in positive territory approximately 4% ahead of the US aggregate bond index.

For 2024, the prospect of synchronized cuts across various EM countries could present ample opportunities across all EM asset classes including credit, local rates, and FX. Some EMs are also benefiting from the ‘friendshoring’ or diversification away from China, which could also spur positive momentum in some countries. Mexico, for example, attracted more than $50 billion in foreign direct investment (FDI) in 2023 (its highest levels in several years). India is also attracting more FDI and it is expected to grow by more than 6.3% in 2024 according to the IMF, its fastest level in several years. At this stage, any normalisation of, or improved, trade relations between the US and China, also could inject optimism and fuel growth in EMs further. The recent meetings between President Biden and Chairman Xi might even give a boost to world trade which has slowed in the last decade.

A weaker US dollar in 2024 would, we believe, generally lead to stronger EM currencies and more relaxed financial conditions, which could allow companies to borrow at lower rates and may initiate a virtuous cycle of growth. The primary markets for EMs effectively have been shut for two years, and falling interest rates could spur some new borrowing which would be beneficial for most high-yield countries, particularly lower GDP Frontier Markets. EM US dollar yields for investors are in our view particularly attractive in the high yield space. At current spreads of 750 bps above US Treasury yields, investors are being compensated more than 125 bps above trailing 10-year averages. There are also more US dollar bonds trading below par and at distressed levels (below 70 cents), providing in our assessment additional opportunities for trading gains in 2024, including some linked to sovereign and corporate debt restructurings.

It has been a tough decade for EM assets, with the last two years being among the most difficult and volatile in 21st century. It appears that the worst is behind us, hopefully ushering a new period of above-market returns from Africa, Asia, the Middle East, Latin America, and Eastern Europe.